These things always seems to happen when I am traveling.

I have yet to fully tear apart the internals of yesterday’s whackage, but we may be looking at more than the run of the mill 5-9% correction that has been the downside limit of the rally dating back to March 2009.

This correction could very well be the first since the bear market bounce began to break the 10% mark.

Coming into 2010, we had been running about 30% cash in our managed accounts. That feels like too much during the spikes up, and not enough during swoons.

During Q1,we made tactical tilts in a few names. We reduced some positions, added others, and liquidated still others. That raised our cash to 40%. This led us to be somewhat defensive during some of the 2010 rally.

A number of long positions were stopped out in Q1 for small losses. That is the nature of our trade discipline. That raised more cash.

Over the past few weeks, several of the names (mentioned here and else where) hit our upside targets: Eastman Kodak (a short squeeze buy), Citigroup (Buy what you hate), the airlines (technical buy), and some of the media positions (Gannet, NYT) were either sold or reduced to take profits. That has taken our cash to over near 50% in April.

We got stopped out of a few names yesterday, and made partial sells in others. As of this morning (with the futures looking up) we are at ~69% cash.

The portfolio changes have been tactical, and not strategic. In other words, the conditions for a major reversal are not conclusive. That doesn’t mean it cannot happen, it just means that at this moment, making decisions with imperfect information, we put the odds of a hefty drop of 20+% at about 25%.

Given that liquidity is still so abundant, we expect the pullback to be somewhat contained, but deeper than the prior 3 wobbles (June, September, January) since the rally began. We could see a deeper than 10% pullback. Depending upon conditions and internals, our expectations are that we will be buyers into a 10-20% correction.  From current levels, we do not expect to revisit the lows.

If the correction fails to materialize, and the market rallies aggressively, with firming internals, we will reconsider our posture. We are always willing to redeploy cash higher into a possible melt up.

I still expect a 25% correction at the end of this rally. I am unable to say with any degree of conviction that the current market turmoil is that major move down.

Regardless, tight stop losses are in order.

Category: Investing, Markets, Technical Analysis, Trading

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

47 Responses to “Market Changes Tone During Correction”

  1. alpha_bet says:

    All of the leading stock markets have started correcting, I see no reason why the US would at least not follow suit for the short term. However, if you watched Liesman on Fast Money last night, he claims that even though decoupling did not work in 2008, he feels certain that this time we can decouple from the EU and most likely the rest of the world. Ah the pleasures of operating in a vacuum.

  2. quiddity says:

    That’s a very helpful situation report. It will affect my thinking (actually, reinforce my view) about the markets.

  3. cewing says:

    Protests are going on in Greece right now. Bloomberg seems to be the only business channel covering it. It looks pretty intense – might have an impact on the markets today, along with the ADP report.

  4. call me ahab says:

    “Given that liquidity is still so abundant, we expect the pullback to be somewhat contained”

    you go BR-

    “liquidity” is your friend- and by the way- an overused word if ever there was one

  5. cognos says:

    Why would we have a large correction, if it only sets up another great up trade?

    Too much support in the economy, jobs, low interest rates, credit cycle. Doesnt make any sense.

    Where are the losses going to come from? (There no more sub-prime losses… in fact subprime bonds are up again ALREADY this month, after going parabolic in April.)

    Too many companies are pretty easy doubles from here over the next year. Why do you think we should have a ’25% correction’ and then those companies should be 4x trades? It makes no sense.

    What I see, is that the commodity sector has already corrected 10-25% because it is most likely to be effected by China and weak EUR. (See FCX, X, CLF, WLT).

  6. Sometimes markets get ahead of themselves . . . and the economy and markets can and do diverge for periods of time.

  7. alpha_bet says:

    Cognos,

    The data is not awful anymore, but its not great and it is definitely fragile. Home prices are starting to turn down again and this will lead to more MBS losses. Government support is coming out of the economy and when this has made up the majority if not all of the income increases over the past several months as well as been the only thing supporting the housing industry, then you are bound to have some readjustments that need to go on. Credit is collapsing and the savings rate can only go up from here. Pretty easy doubles over the next year? I am not so sure how easy it is going to be.

  8. postman says:

    Unlike the prior stock market wobbles accompanied by a strong $ and long bond, gold has been showing impressive relative strength, although it still declined a bit yesterday. In the huge ’07-’09 swoon and in the more recent wobbles, gold was hit hard. Not so yesterday and in the futures market overnight and this morning. Gold’s safe harbor component appears to be outweighing its risk element.

  9. Dennis says:

    Very helpful — thank you.

    I know you cant do these all the time, but this post — and the macro overview last week — really help manage my thinking and investment process.

    Much appreciated

  10. It’s just a single data point but I think it mirrors what has happened to the US domestic economy.

    Local new car registrations for April.

    2007 – 526
    2008 – 398
    2009 – 215
    2010 – 290

    So you can see that yes, local dealers sold 75 more cars this month than last year which was the bottom for just about everything – stocks, economy, etc…

    However, despite this slight improvement we’re still 25-40% below where we were a couple of years ago. Things are not “back to normal” in the rest of the US outside of a few pockets of wealth near the financial hubs.

  11. cognos says:

    I would guess that we’re closer to the end of the correction. Might see 1,150 or in some real extreme case of surprising bad news flow 1,120 on SPX.

    But generally… German ratification of the Greek bailout, strong NFP in the US on Friday, complete fixes of this BP oil leak in the gulf, GS settling with SEC, AAPL actually saying — “uh, were gonna blow out the Q and the YR (and the decade?). cannot make enough iPads”

    And then market should continue up through 1,300 and 1,400. People are productive and wealthy. T$ is still earning 0.10% in bills and money market accounts.

  12. ashpelham2 says:

    Really conflicting view points here. I think all of them have some valid points. I guess I’m still longing for the BIG PICTURE, which takes into account not only market exchanges, but the overall economy and all of it’s components as well. I believe the grand scheme of things paints a continued deleverage, shrinking of the overall economy. I didn’t really have anything but some anecdotal evidence of this trend until recently, when I’ve noticed customers of ours, as well as retailers I occasionally frequent, just flat out have less demand and less to offer. We are in shrink mode, but profits are still to be made at the corporate level. This will push financial markets higher.

    Only places in the economy that matter to me are the energy spectrum, and the economic policy spectrum. Everything else just rolls up into those two.

  13. Mannwich says:

    Welcome to the “new normal”, folks. Get used to it. I HEART ZIRP 4-EVA.

  14. seneca says:

    The obvious initial downside target is the previous peak in January of 1,150 on the S&P500. That would amount to only a 4.5 percent correction. A return to the February lows would be a 10 percent correction. Given the good technicals leading into this pullback, the decline should end somewhere between those two points.

  15. flipspiceland says:

    When do interest rates go below 0?

  16. Mannwich says:

    Soon, flip. Soon.

  17. Niskyboy says:

    Thank you, Barry.

  18. ashpelham2 says:

    And when those rates dip below zero, how long will the Fed allow that to hold? Does it change the relationship between savers and depository institutions further? Are we as investors going to be FORCED into equities to earn a return?

  19. mad97123 says:

    Interesting to find out your accounts were 30-70% cash through the rally.

    After your ‘Lagging Psychology at Turning Points’ and ’10 Psychological, Valuation, Adapative Investing Rules’ post I was feeling like an idiot for not being ‘all in’ for the obvious (with hindsight) rally. Sounds like I was in good company!

    • Market Pros simply cannot afford to sit out a 75% rally; Individuals that miss that sort of move should reconsider their investment strategies immediately.

  20. Bullseye says:

    Your insights always passed the “common sense” instinct test for me (a non-financial person). After reminding everyone of the importance of “stop loss” orders the day before the market turned, my respect for you and gratitude have both gone even higher.

    Thanks for leading some of us ignorant masses through this.

  21. Mark Down says:

    25% correction.. I’ll take the other side of that bet.

  22. HEHEHE says:

    The liquidity and government generated “expansion” is already baked into the market. The only way from here is down. And corrections can go lower than expected just as much as rallies can surprise on the up side. I am not saying we’ll get back to new lows but 800′s would not shock me.

  23. The Curmudgeon says:

    Real interest rates (nominal rates minus the inflation rate) already are below zero. This is typical in an inflationary monetary regime. Real rates tracked below zero for most of the seventies. The supply of money exceeds its demand, just like the supply and demand metrics for housing and a myriad of other industries that would have nominally lower prices were it not for the massive amounts of cash floating around. Instead of allowing the prices for goods and services to decline, the price for money is being held artificially low. Just because prices aren’t barrelling upward across the board, doesn’t mean there isn’t inflation. If prices would decrease but for the cheapening money, then you still have inflation.

    Which makes any kind of massive sell-off in equities unlikely, and remarkable, if it happens. It would mean that even with an inflationary monetary regime, all the kings horses and all the kings men still can’t put the 401K back together again.

  24. Bsideriver says:

    The clincher for me was William Hesters article about the presidential cycle. Now is not the time to ignore the fact that Q2 and Q3 of year 2, are the worst quarters in a presidential term.

  25. catman says:

    BR is doing a consistent job with OPM. I think his caution is likely overdone, but I dont have the same responsibilities or size issues.

  26. DeDude says:

    @HEHEHE; I would be chocked if we went down to 800′s but just below 1K would not be a shock. I agree with a lot of the happy talk from cognos, but agree with you that it is already baked into the market. None of it is surprising or new so it has already been priced in. We are a lot more likely to get a few bad surprises than a few good surprises in the next few months (from the tail of the PIIGS ?), so I wouldn’t be surprised if the “sell-in-May” crowd come back with their cash at a close to 1K level.

  27. MelJ says:

    Is there a conflict between your statement today May 5
    about your recent trades, “That has taken our cash to over
    near 50% in April” and your statement less than a week ago
    April 29
    ,
    “Despite the recent turmoil, we have not found confirmation that
    the bull run is over — yet.”?

  28. cognos says:

    So… why a big pullback?

    The big 2008, Q1 2009 correction was caused by a) massive losses across the banking sector that b) put us on borderline “nationalization” of banks and the verge of a great depression. BSC, AIG, LEH, FNM, FRE, and WaMu and Wachovia went bankrupt. That’s over.

    EPS estimate for SPX were written down to $40-50 in Jan, Feb for 2009. They came in at $65. Now they are coming in at $85 for 2010.

    I dont see the “real losses” that change that. It WAS NOT sentiment that caused 2008 recession. It was real built in losses. Sentiment causes 5-7% pullbacks that move into 10-15% gains as the recovery continues. You want to buy those dips.

    Only thing I have heard here, which this dumb Meredith Whitney (bearish on banks in June 09, loud and bearish in Nov/Dec 09 – Man! that call is down 100% or more!) is saying, is “housing is turning down”. Thats a total red herring. It may not be turning up. It may be choppy (+/- a few %). It may even gradually slide down 3% annually for 5 years. I dont think so, but it wont matter. Its not going down 20% annual again. Non-sense. Banks remain OVER-reserved for credit losses.

    Dow is up. SPX flat. Hmm… maybe buying the dips works?

  29. Marcus Aurelius says:

    DeDude Says:

    “I agree with a lot of the happy talk from cognos, but agree with you that it is already baked into the market. None of it is surprising or new so it has already been priced in.”
    ________________

    The losses have not been priced in — they have been swept under the rug, but are no less toxic there than they would be as the centerpiece on the banquet table. If the losses had been priced in (counterparties and all), none of our banks would be a going concern (and as the banks go, so goes the economy), and the markets would tank. The withdrawal of stimulus will once again expose what is now out of sight and out of mind.

    It’s contained (until it isn’t).

  30. NormanB says:

    BR: Thanks for the transparency. My input is that -25% is a bear market and not a ‘correction’. So, I’d have to classify you as big bear, dancing feet not-with-standing. And I think stops are ok to be used in a topping market or if you think a bear market is in the making but in a bull market (I see absolutely no evidence the bull has come close to faltering) stops just get you whipsawed unless you have a hair trigger stop buy in place also.

  31. DeDude says:

    Marcus; there could be a bad surprise from the bank sector but they have had time to recover from some of their worst stupidities so the statement that “none of our banks would be a going concern” is just a bunch of doomsday dreams. Maybe 2 or 3 of the big 19 could fall if all the loses were to be recognized but that’s about it. Remember most of that less than 10 cent on the dollar paper from a year ago is now selling for more than 50 cent.

    The banking thing that could be a bad surprise is if Spain goes down. In contrast to Portugal, Spain is to big to bail. No way they could come up with the money needed to save them. So if they go down the bondholders would be forced to take some kind of a loss.

    I still think the way to do this for the PIIGS is to stop paying bondholders 100 cent on the dollar and instead give them a longer term paper with a 4% rate. For holders of maturity of 5 year and less give a 10 year 4% bond instead of their money, and all holders of over 5 year bonds get a 30 year 4% bond instead of their money, at maturity. Do that for up to 10 years, then the only thing IMF/EU has to do, is to cover the budget deficit for a few years until the country has adjusted its taxes to cover its expenses.

  32. scepticus says:

    Will the ECB begin QE? If so, then that only catches these euro laggards up to the rest of the forward thinking western economies!

    Credit crunch part deux, but with higher stakes. From ft alphaville:

    http://ftalphaville.ft.com/blog/2010/05/05/219641/%E2%80%98the-ecb-will-be-forced-into-the-end-game/

    “We think that the ECB will be forced into the end game (buying peripheral European debt) and, if necessary, to ring-fence Greece by announcing a huge support package for Spain. We believe that the ECB has no other option. European banks hold, we believe, about $75bn of Greek, $46bn of Portuguese and $85bn of Spanish government debt (with around 80% of total Greek government debt being held by foreigners). In total, European banks hold $190bn of Greek assets, as well as $850bn of assets in Spain and $241bn in Portugal. (This is public and private and includes minority holdings) . . .”

    Q: when will rates go below 0?

    they will, but not yet. Steps on the way to negative nominal rates (NNR):

    * bring europe up to speed with QE
    * return of deflation, plus nasty crash in the commod countiries (Oz, canada etc)
    * a couple more sov debt crises in nations having their own printing presses and the odd revolution in europe and asia
    * china crash
    * NOW we can have NNR, cos there’s nowhere left for hot money to run.

  33. scepticus says:

    @curmudgeon, if the supply of money exceeds the demand for it, then if we stop pumping and let prices decline then the real interest rate accruing to money holders is quite strongly positive, which will have a very bad ending.

    for prices to truely decline within an otehrwise reasonably well functioning economy the nominal rate needs to be negative, even while the real rate may be positive.

    ofc, there is no possibility of putting the 401k charade back together again. 401K is one of the reasons we are in this mess in the first place. whoever thought of the idea of turning every mom and pop into a capitalist rentier come age 65? bad idea – if you happen to be a real running dog.

  34. [...] seen since the rally began in March 2009, especially as the market tone seems to be shifting, writes FusionIQ CEO Barry [...]

  35. TakBak04 says:

    Thanks BR!

    As one of your “small investors,” I found your post on this very informative.

    It will help me in my planning…

    I do think that not all your readers are “Traders or Hedgies” but folks looking for strategy. You’ve been good at providing a “balance.

    That is a very welcomed thing in these times.

  36. TakBak04 says:

    Marcus Aurelius Says:
    May 5th, 2010 at 12:01 pm

    DeDude Says:

    “I agree with a lot of the happy talk from cognos, but agree with you that it is already baked into the market. None of it is surprising or new so it has already been priced in.”
    ________________

    The losses have not been priced in — they have been swept under the rug, but are no less toxic there than they would be as the centerpiece on the banquet table. If the losses had been priced in (counterparties and all), none of our banks would be a going concern (and as the banks go, so goes the economy), and the markets would tank. The withdrawal of stimulus will once again expose what is now out of sight and out of mind.

    It’s contained (until it isn’t).

    ———–

    Cognos hasn’t learned what you say…….YET! It will be interesting to see what the “Flaming Bulls” do in the coming years. They may have to “revise strategy” quite often. Not dissing their view …but there does seem to be much “Irrational Exuberance” still lingering from the Greenspeak years which might be what Larry Kudlow is still smoking as he appears day after day in excrutiating agony promoting what he’s told by his “Think Tank Buddies” who are probably still “paying him under the table.” SHAME ON ME FOR SAYING THIS! ….YEAH!

  37. chomen says:

    My first reaction to your post is that it’s way too reasonable.

  38. perra says:

    Another interesting read is Jeremy Bentham’s (GMO) Q1 report:
    http://www.gmo.com/websitecontent/JGLetter_ALL_1Q10.pdf

    Barry, Bentham has stepped up the game. You are now required to quantify your predictions by producing a decision tree… (see Exhibit 1 of the Bentham report).

    takbak04 said:
    - “Cognos hasn’t learned what you [BR] say…”. My question: Where in North Korea is “Takbak”?
    - “It will be interesting to see what the “Flaming Bulls” do in the coming years.” My answer: They will spend trading profits you won’t have while listening to Diana Ross.

  39. MikeW says:

    Having sold a big chunk of my SP500 index holdings at about the 920 level, I’d love to see the market ‘correct’ (lovely euphemism, that) somewhere in the neighborhood of 25%.

    Trouble is, I’m having as much difficulty removing emotion from my judgement now as I did when fear drove me to sell last year. At least now I’m more conscious of it, whatever good that does.

    And most importantly, what does one do with all those cash proceeds for the long haul?

    With interest rates having nowhere to go but up and governments worldwide apparently competing to see which can become most indebted, fixed income and cash both look like bad long-term bets.

    Gold might be OK (I’m certainly overweight GLD/SLV myself) for a small portion, but it’s another risky trade and notoriously difficult to time correctly.

    Emerging? Some say China is a bubble, and is at least rather opaque from this distance.

    Europe? Welfare states with scary demographics.

    Commodities? Maybe some, but it’s another spin of the roulette wheel, isn’t it?

    Hows this? Tax-efficient equity index funds for the taxable accounts, and solid, reliable dividend growers (ABT, JNJ, whatever) in the qualified accounts.

    Sorry I don’t have anything more affirmative to add, I just find this to be the most confusing time to be an investor in memory and don’t know what the heck to do anymore. We are all of us forced to become serial speculators, and let’s face it, that’s not something most of us are good at.

  40. TakBak04 says:

    @scepticus Says:
    May 5th, 2010 at 4:02 pm

    @curmudgeon, if the supply of money exceeds the demand for it, then if we stop pumping and let prices decline then the real interest rate accruing to money holders is quite strongly positive, which will have a very bad ending.

    for prices to truely decline within an otehrwise reasonably well functioning economy the nominal rate needs to be negative, even while the real rate may be positive.

    ofc, there is no possibility of putting the 401k charade back together again. 401K is one of the reasons we are in this mess in the first place. whoever thought of the idea of turning every mom and pop into a capitalist rentier come age 65? bad idea – if you happen to be a real running dog.

    —–

    Just wait until they Privatize SS and tell those folks under 40 that it is so good for them to have control over their own savings for their retirement. Wall Street is just waiting for that new influx of funds after they shafted the older savers in their 401-K’s, IRA’s who took the crash and got scared out but can’t make any money safe…so they have to keep in there with the fees and the rest.

    What a scam that was…and will be in the future….

  41. princess says:

    Another thanks, Barry, for your help in careful planning – capital preservation and gain both important.

  42. [...] light of this morning’s commentary, a few emailers asked me were we stood after today’s [...]

  43. andrewp111 says:

    Negative Nominal Rates? How does one violate the so-called “zero-bound” for more than fleeting, temporary moments? People will take money out in cash if this happens, but I guess that is hard when big amounts are at issue. I wouldn’t put it past the US Government to try this though.

    With all the new information and database powers the Gov’t is getting with its financial “reform” bill, they could simply identify those of you who are being too miserly, and give you an order — spend x$ by mm-dd-yy, or else that amount simply expires and vanishes forever. Everyone has a duty to support the National economy. Money in cash and gold could also be taxed away if they are able to reliably know how much you have.

  44. [...] This sell-off could be different than the dips we've seen thus far during the rally.  (TBP) [...]

  45. scepticus says:

    andrewp111, it is impossible for instituional investors, sov wealth funds and pension funds to take money out in cash as you put it. even if there were enough paper cash for that, which there isn’t, it wouldn’t be practical because the carrying costs of several billion in paper notes likely exceeds any negative nominal rate.

    besides which, if investors are earning a positive real return since the money supply is contracting, one wonders what the beef is?

    just inflation illusion, I suppose

  46. financial matters says:

    Freddie Mac just said they need another $10 billion from the US taxpayer for the 2nd qtr of this year. We have told Fannie and Freddie that we will buy all the toxic non-performing loans with no limit. This is replacing the Feds buying of these as they already have a pretty full balance sheet of them. An audit of the Fed would likely also show that the non-interest loans that they are providing banks are being plowed into the stock market to try and pump up bank/financial sector stocks ala plunge protection team.

    When the fear factor collides with the inability or lack of desire of the Fed and the US govt to continue to bailout a largely insolvent and corrupt financial sector then we could see more 1000 point day losses…

  47. [...] last weeks Wednesday morning and late night discussions about moving to 100% cash, the office phones lit up — long/short [...]